| | | | | | | |
| | Nine months ended September 30, | |
| | 2008 | | 2007 | |
| | | | | |
Cash flows from operating activities | | | | | | | |
Net (loss) income | | $ | (25,608 | ) | $ | 2,674 | |
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities | | | | | | | |
Impairment of proved properties | | | 19,579 | | | — | |
Depletion and amortization | | | 1,682 | | | 5,541 | |
Dry-hole costs | | | (94 | ) | | 86 | |
Accretion expense | | | 8 | | | 4 | |
Amortization of premium | | | 242 | | | — | |
Interest earned on marketable securities | | | (374 | ) | | (1,053 | ) |
Changes in assets and liabilities: | | | | | | | |
Decrease (increase) in production receivable | | | 1,556 | | | (474 | ) |
(Increase) decrease in other current assets | | | (82 | ) | | 127 | |
Increase in due to operators | | | 1,143 | | | 25 | |
Increase in accrued expenses payable | | | 42 | | | 12 | |
| | | | | | | |
Net cash (used in) provided by operating activities | | | (1,906 | ) | | 6,942 | |
| | | | | | | |
| | | | | | | |
Cash flows from investing activities | | | | | | | |
Payments to operators for working interests and expenditures | | | (166 | ) | | — | |
Capital expenditures for oil and gas properties | | | (14,085 | ) | | (12,324 | ) |
Proceeds from held-to-maturity investments | | | 57,073 | | | 37,134 | |
Investment in held-to-maturity securities | | | (24,001 | ) | | (55,131 | ) |
Investment in available-for-sale securities | | | (9,764 | ) | | — | |
Interest reinvested in salvage fund | | | (22 | ) | | (37 | ) |
| | | | | | | |
Net cash provided by (used in) investing activities | | | 9,035 | | | (30,358 | ) |
| | | | | | | |
| | | | | | | |
Cash flows from financing activities | | | | | | | |
Distributions | | | (3,465 | ) | | (8,304 | ) |
| | | | | | | |
Net cash used in financing activities | | | (3,465 | ) | | (8,304 | ) |
| | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 3,664 | | | (31,720 | ) |
Cash and cash equivalents, beginning of period | | | 8,427 | | | 49,055 | |
| | | | | | | |
Cash and cash equivalents, end of period | | $ | 12,091 | | $ | 17,335 | |
| | | | | | | |
The accompanying notes are an integral part of these unaudited condensed financial statements.
RIDGEWOOD ENERGY Q FUND, LLC
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
| |
1. | Organization and Purpose |
The Ridgewood Energy Q Fund, LLC (the “Fund”), a Delaware limited liability company, was formed on August 16, 2005 and operates pursuant to a limited liability company agreement (the “LLC Agreement”) dated as of September 6, 2005 by and among Ridgewood Energy Corporation (the “Manager”), and the shareholders of the Fund. The Fund was organized to acquire interests in oil and gas properties located in the United States offshore waters of Texas, Louisiana and Alabama in the Gulf of Mexico.
The Manager performs, or arranges for the performance of, the management and administrative services required for Fund operations. Such services include, without limitation, the administration of shareholder accounts, shareholder relations and the preparation, review and dissemination of tax and other financial information. In addition, the Manager provides office space, equipment and facilities and other services necessary for Fund operations. The Manager also engages and manages the contractual relations with unaffiliated custodians, depositories, accountants, attorneys, broker-dealers, corporate fiduciaries, insurers, banks and others as required. See Notes 2, 6 and 8.
| |
2. | Summary of Significant Accounting Policies |
Basis of Presentation
These unaudited interim condensed financial statements have been prepared by the Fund’s management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in the opinion of management, contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Fund’s financial position, results of operations and cash flows for the periods presented. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted in these unaudited interim condensed financial statements. The results of operations, financial position, and cash flows for the periods presented herein are not necessarily indicative of future financial results. These unaudited interim condensed financial statements should be read in conjunction with the annual financial statements and the notes thereto for the year ended December 31, 2007 included in the Fund’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”). The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Manager reviews its estimates, including those related to amounts advanced to and billed by operators, determination of proved reserves, impairments and asset retirement obligations. Actual results may differ from those estimates.
Cash and Cash Equivalents
All highly liquid investments with maturities, when purchased, of three months or less, are considered cash and cash equivalents. At times bank deposits may be in excess of federally insured limits. At September 30, 2008 and December 31, 2007, bank balances, inclusive of salvage fund, exceeded federally insured limits by $4.0 million and $5.2 million, respectively. At September 30, 2008, $3.2 million of the Fund’s uninsured balances were invested in money market accounts that invest solely in U.S. Treasury Bills and Notes. The Fund maintains bank deposits with accredited financial institutions.
Effective October 3, 2008 through December 31, 2009, federally insured limits have been increased from $0.1 million to $0.25 million.
Investments in Marketable Securities
At times the Fund may invest in U.S. Treasury bills and notes. These investments are considered short-term when their maturities, when purchased, are greater than three months and one year or less, and long-term when their maturities are in excess of twelve months. The Fund currently has short-term investments that are classified as held-to-maturity. Held-to-maturity securities are those investments that the Fund has the ability and intent to hold until maturity, and are recorded at cost plus accrued income, adjusted for the amortization of premiums and discounts, which approximates fair value. At September 30, 2008 and December 31, 2007, the Fund had held-to-maturity investments totaling $5.0 million and $37.7 million, respectively. The held-to-maturity investments held at September 30, 2008 mature in February 2009.
4
The Fund currently has long-term investments, which mature in February 2010, that are classified as available-for-sale. Available-for-sale securities are carried in the financial statements at fair value. The following table is a summary of long-term, available-for-sale investments at September 30, 2008:
| | | | | | | | | | |
| | Amortized
Cost | | Gross
Unrealized
Gains | | Fair
Value | |
| | | | | | | |
| | | | (in thousands) | | | |
Available-for-Sale | | | | | | | |
U.S Treasury notes | | | | | | | | | | |
September 30, 2008 | | $ | 9,522 | | $ | 115 | | $ | 9,637 | |
For all investments, interest income is accrued as earned and amortization of premium or discount, if any, is included in interest income. Unrealized gains or losses for available-for-sale securities are reported in other comprehensive income until realized.
Salvage Fund
The Fund deposits in a separate interest-bearing account, or a salvage fund, money to provide for dismantling production platforms and facilities, plugging and abandoning the wells and removing the platforms, facilities and wells after their useful lives, in accordance with applicable federal and state laws and regulations. At September 30, 2008 and December 31, 2007, the Fund had held-to-maturity investments within its salvage fund totaling $1.1 million. The held-to-maturity investment held within the salvage fund at September 30, 2008 matures in February 2012.
Interest earned on the account will become part of the salvage fund. There are no restrictions on withdrawals from the salvage fund.
Oil and Gas Properties
Investments in oil and gas properties are operated by unaffiliated entities (“Operators”) who are responsible for drilling, administering and producing activities pursuant to the terms of the applicable operating agreements with working interest owners. The Fund’s portion of exploration, drilling, operating and capital equipment expenditures relating to the wells are advanced and billed by Operators through authorization for expenditures.
The successful efforts method of accounting for oil and gas producing activities is followed. Acquisition costs are capitalized when incurred. Other oil and gas exploration costs, excluding the costs of drilling exploratory wells, are charged to expense as incurred. The costs of drilling exploratory wells are capitalized pending the determination of whether the wells have discovered proved commercial reserves. If proved commercial reserves have not been found, exploratory drilling costs are expensed to dry-hole expense. Costs to develop proved reserves, including the costs of all development wells and related facilities and equipment used in the production of crude oil and gas, are capitalized. Expenditures for ongoing repairs and maintenance of producing properties are expensed as incurred.
Upon the sale or retirement of a proved property, the cost and related accumulated depletion and amortization will be eliminated from the property accounts, and the resultant gain or loss is recognized. Upon the sale or retirement of an unproved property, gain or loss on the sale is recognized. The Manager does not currently intend to sell any of the Fund’s property interests.
Capitalized acquisition costs of producing oil and gas properties are depleted by the unit-of-production method.
At September 30, 2008 amounts recorded in due to operators totaling $0.7 million related to capital expenditures for oil and gas property. These amounts were principally paid during the fourth quarter of 2008.
Advances to Operators for Working Interests and Expenditures
The Fund’s acquisition of a working interest in a well or a project may require it to make a payment to the seller for the Fund’s right, title and interest. The Fund may be required to advance its share of estimated cash expenditures for the succeeding month’s operation. The Fund accounts for such payments as advances to Operators for working interests and expenditures. As drilling costs are incurred, the advances are transferred to unproved properties.
5
Asset Retirement Obligations
For oil and gas properties, there are obligations to perform removal and remediation activities when the properties are retired. When a project reaches drilling depth and is determined to be either proved or dry, an asset retirement obligation is incurred. Plug and abandonment costs associated with unsuccessful projects are expensed as dry-hole costs. The table below presents changes for the nine months ended September 30, 2008 and the year ended December 31, 2007.
| | | | | | | |
| | September 30, 2008 | | December 31, 2007 | |
| | | | | |
| | (in thousands) | |
Balance - Beginning of period | | $ | 184 | | $ | 79 | |
Liabilities incurred | | | 198 | | | 99 | |
Liabilities settled | | | — | | | — | |
Accretion expense | | | 8 | | | 6 | |
| | | | | | | |
Balance - End of period | | $ | 390 | | $ | 184 | |
| | | | | | | |
As indicated above, the Fund maintains a salvage fund to provide for the funding of future asset retirement obligations.
Syndication Costs
Syndication costs are direct costs associated with offering the Fund’s shares including professional fees, selling expenses and administrative costs payable to the Manager, an affiliate of the Manager and unaffiliated broker-dealers, which are reflected on the Fund’s balance sheet as a reduction of shareholders’ capital.
Revenue Recognition and Imbalances
Oil and gas revenues are recognized when production is sold to a purchaser at a fixed or determinable price, when delivery has occurred and title has transferred, and if collectibility of the revenue is probable.
The Fund uses the sales method of accounting for gas production imbalances. The volumes of gas sold may differ from the volumes to which the Fund is entitled based on its interests in the properties. These differences create imbalances that are recognized as a liability only when the properties’ estimated remaining reserves net to the Fund will not be sufficient to enable the underproduced owner to recoup its entitled share through production. The Fund’s recorded liability, if any, would be reflected in other non-current liabilities. No receivables are recorded for those wells where the Fund has taken less than its share of production. Gas imbalances are reflected as adjustments to estimates of proved gas reserves and future cash flows.
Impairment of Long-Lived Assets
In accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of Long-Lived Assets”, long-lived assets, such as oil and gas properties, are evaluated when events or changes in circumstances indicate the carrying value of such assets may not be recoverable. The determination of whether impairment has occurred is made by comparing the carrying values of long-lived assets to the estimated future undiscounted cash flows attributable to the asset. The impairment loss recognized is the excess of the carrying value over the future discounted cash flows attributable to the asset or the estimated fair value of the asset.
During the three and nine months ended September 30, 2008, the Fund recorded an impairment loss of $19.6 million related to its investment in the Main Pass 30 field. In February 2008, Main Pass 30 well #2 stopped flowing gas due to a mechanical problem. During the second and third quarters, the Operator completed a workover process at a cost of $4.4 million that has not proved successful and the Fund and the Operator have elected to plug and abandon this well. As a result, in accordance with SFAS No. 144, the Fund determined that the Main Pass 30 field was impaired and recorded an impairment loss totaling $19.6 million. At September 30, 2008, the unamortized remaining balance of the Main Pass 30 field’s proved properties, which excludes Main Pass 30 well #3 as it is currently drilling, is $0.4 million. For the three and nine months ended September 30, 2007, no impairments were recorded.
The fair value used in the impairment calculation was based upon futures pricing at the date of the calculation. In determining the fair value, the Manager relies upon a number of factors including reserve data and futures pricing of oil and gas as of the date of calculation. There are inherent uncertainties related to these factors and judgments in applying them to the impairment analysis. Reservoir engineering is a subjective process of estimating underground accumulations of gas and oil that cannot be measured in an exact manner. The reserve estimates are based upon the quality of available data and engineering and geological interpretation and judgment. Revisions to estimated reserves may result from actual production, results of future development and exploration activities, prevailing oil and gas prices, operating costs and other factors. Changes to these factors and judgments may result in additional impairments.
Depletion and Amortization
Depletion and amortization of the cost of proved oil and gas properties are calculated using the units-of- production method. Proved developed reserves are used as the base for depleting the cost of successful exploratory drilling and development costs. The sum of proved developed and proved undeveloped reserves is used as the base for depleting, or amortizing, leasehold acquisition costs, the costs to acquire proved properties and platform and pipeline costs.
6
Income Taxes
No provision is made for income taxes in the financial statements. The Fund is a limited liability company, and as such, the Fund’s income or loss is passed through and included in the tax returns of the Fund’s shareholders.
Income and Expense Allocation
Profits and losses are allocated 85% to shareholders in proportion to their relative capital contributions and 15% to the Manager, except for interest income and certain expenses such as dry-hole costs, fiduciary fees, depletion and amortization, which are allocated 99% to shareholders and 1% to the Manager.
3. Recent Accounting Standards
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS No.162”), which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with GAAP. SFAS No. 162 will be effective sixty days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411. The Fund does not expect the adoption of SFAS No. 162 will have a material impact on its financial condition or results of operation.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS No.157”), which applies under most other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 provides a common definition of fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants. The new standard also provides guidance on the methods used to measure fair value and requires expanded disclosures related to fair value measurements. SFAS No. 157 had originally been effective for financial statements issued for fiscal years beginning after November 15, 2007, however the FASB has agreed on a one year deferral for all non-financial assets and liabilities. On January 1, 2008, the Fund adopted SFAS No. 157 for financial assets and liabilities.
4. Unproved Properties - Capitalized Exploratory Well Costs
Leasehold acquisition and exploratory drilling costs are capitalized pending determination of whether the well has found proved reserves. Unproved properties are assessed on a quarterly basis by evaluating and monitoring if sufficient progress is made on assessing the reserves.
The following table reflects the net changes in unproved properties for the nine months ended September 30, 2008 and the year ended December 31, 2007. As of September 30, 2008, the Fund had no capitalized exploratory well costs greater than one year.
| | | | | | | |
| | September 30, 2008 | | December 31, 2007 | |
| | | | | |
| | (in thousands) | |
Balance - Beginning of the period | | $ | 10,839 | | $ | 450 | |
Additions to capitalized exploratory well costs pending the determination of proved reserves | | | 6,061 | | | 20,080 | |
Reclassifications to proved properties based on the determination of proved reserves | | | (5,404 | ) | | (9,691 | ) |
Capitalized exploratory well costs adjusted | | | (3,953 | ) | | — | |
| | | | | | | |
|
Balance - End of the period | | $ | 7,543 | | $ | 10,839 | |
| | | | | | | |
7
Capitalized exploratory well costs adjusted represents costs of $4.0 million that were reclassified to insurance receivable, related to the Main Pass 30 well #3 insured loss. See Note 8 for additional discussion.
Capitalized exploratory well costs are expensed as dry-hole costs in the event that reserves are not found or are not in sufficient quantities to complete the well and develop the field. During the nine months ended September 30, 2008, the Main Pass 221 project received credits from the Operator based upon review and audit of the well costs. Dry-hole costs, inclusive of credits, are detailed in the table below.
| | | | | | | | | | | | | |
| | Three months ended
September 30, | | Nine months ended
September 30, | |
Lease Block | | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | | |
| | (in thousands) | |
Main Pass 221 | | $ | 31 | | $ | 1 | | $ | (94 | ) | $ | 86 | |
5. Distributions
Distributions to shareholders are allocated in proportion to the number of shares held.
The Manager will determine whether available cash from operations, as defined in the Fund’s LLC Agreement, is to be distributed. Such distributions will be allocated 85% to the shareholders and 15% to the Manager, as required by the Fund’s LLC Agreement.
Available cash from dispositions, as defined in the Fund’s LLC Agreement, will be paid 99% to shareholders and 1% to the Manager until the shareholders have received total distributions equal to their capital contributions. After shareholders have received distributions equal to their capital contributions, 85% of available cash from dispositions will be distributed to shareholders and 15% to the Manager.
The Fund made distributions to the Fund’s shareholders during the nine months ended September 30, 2008 and 2007 totaling $2.9 million and $7.1 million, respectively. The Fund made distributions to the Manager during the nine months ended September 30, 2008 and 2007 totaling $0.5 million and $1.2 million, respectively.
6. Related Parties
The Fund’s LLC Agreement provides that the Manager render management, administrative and advisory services. For such services, the Manager receives an annual management fee, payable monthly, of 2.5% of total capital contributions, net of cumulative dry-hole and related well costs incurred by the Fund. Management fees for each of the three and nine months ended September 30, 2008 and 2007 were $0.7 million and $2.0 million, respectively.
From time to time, short-term payables and receivables, which do not bear interest, arise from transactions with affiliates in the ordinary course of business. At September 30, 2008 and December 31, 2007, there were no such amounts outstanding.
None of the compensation paid to the Manager has been derived as a result of arm’s length negotiations.
The Fund has working interest ownership in certain projects to acquire and develop oil and gas projects with other entities that are likewise managed by the Manager.
7. Fair Value of Financial Instruments
At September 30, 2008 and December 31, 2007, the carrying value of cash and cash equivalents, investments in marketable securities, salvage fund, production receivable and accrued expenses approximate fair value.
In accordance with SFAS No. 157, the Fund’s available-for-sale investments are measured utilizing Level 1 inputs, which include quoted prices in active markets.
8. Commitments and Contingencies
Capital Commitments
The Fund has entered into multiple offshore operating agreements for the drilling and development of its investment properties. The estimated capital expenditures associated with these agreements vary depending on the stage of development on a property-by-property basis. As of September 30, 2008, the Fund had committed to spend an additional $19.0 million related to its investment properties.
8
Environmental Considerations
The exploration for and development of oil and gas involves the extraction, production and transportation of materials which, under certain conditions, can be hazardous or cause environmental pollution problems. The Operators are continually taking action they believe appropriate to satisfy applicable federal, state and local environmental regulations and do not currently anticipate that compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, results of operations or the competitive position of the Fund in the oil and gas industry. However, due to the significant public and governmental interest in environmental matters related to those activities, the Manager cannot predict the effects of possible future legislation, rule changes, or governmental or private claims. At September 30, 2008 and December 31, 2007, there were no known environmental contingencies that required the Fund to record a liability.
Insurance Coverage
The Fund is subject to all risks inherent in the exploration for and development of oil and gas. Insurance coverage as is customary for entities engaged in similar operations is maintained, but losses may occur from uninsurable risks or amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon earnings and financial position. Moreover, insurance is obtained as a package covering all of the Manager’s investment programs. Claims made by other such programs can reduce or eliminate insurance for the Fund.
At September 30, 2008, an insurance claim was filed by the Fund related to Main Pass 30 well #3. Drilling on this well commenced in October 2007. In December 2007, the Fund encountered a mechanical problem, or underground “blowout”, caused by a small pocket of gas. The Fund expects the losses relative to this insured event to total $9.0 million at completion. During the third quarter 2008, the Fund filed a claim for $4.5 million related to insured costs incurred through September 30, 2008. The Fund expects to spend an additional $14.4 million to complete the drilling of this well, of which an additional $5.0 million is expected to be reimbursed by the Fund’s insurer. At September 30, 2008 an insurance recovery receivable of $4.0 million has been recorded by the Fund relative to this claim, net of its $0.5 million insurance deductible. The Fund records receivables for insured losses when the expected insurance proceeds are probable and reasonably estimable.
9
|
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Cautionary Statement Regarding Forward-Looking Statements
Certain statements in this quarterly report on Form 10-Q (“Quarterly Report”) and the documents Ridgewood Energy Q Fund, LLC (the “Fund”) has incorporated by reference into this Quarterly Report, other than purely historical information, including estimates, projections, statements relating to the Fund’s business plans, strategies, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “target,” “pursue,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Examples of such events that could cause actual results to differ materially from historical results or those anticipated include weather conditions, such as hurricanes, changes in market conditions affecting the pricing of oil and gas, the cost and availability of equipment, and changes in governmental regulations. The Fund undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Critical Accounting Policies and Estimates
The following discussion and analysis of the Fund’s financial condition and operating results is based on its financial statements. The preparation of this Quarterly Report requires the Fund to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Fund’s financial statements, and the reported amount of revenue and expenses during the reporting period. Actual results may differ from those estimates and assumptions. See “Notes to Unaudited Condensed Financial Statements” in Part I of this Quarterly Report for a presentation of the Fund’s significant accounting policies. No changes have been made to the Fund’s critical accounting policies and estimates disclosed in its 2007 Annual Report on Form 10-K.
Overview of the Fund’s Business
The Fund is a Delaware limited liability company formed on August 16, 2005 to acquire interests primarily in oil and gas projects located in the U.S. waters of the Gulf of Mexico. Ridgewood Energy Corporation, (“Ridgewood Energy” or the “Manager”) a Delaware corporation, is the Manager. As the Manager, Ridgewood Energy has direct and exclusive control over the management and control of Fund operations. The Fund’s primary investment objective is to generate cash flow for distribution to the Fund’s shareholders through participation in oil and gas exploration and development projects in the Gulf of Mexico.
The Manager performs certain duties on the Fund’s behalf including the evaluation of potential projects for investment and ongoing management, administrative and advisory services associated with these projects. For these services, the Manager receives an annual management fee equal to 2.5% of capital contributions, net of cumulative dry-hole and related well costs incurred by the Fund, payable monthly. The Fund does not currently, nor is there any plan to operate any project in which the Fund participates. The Manager enters into operating agreements with third-party operators (“Operators”) for the management of all exploration, development and producing operations, as appropriate. The Manager also participates in distributions.
Business Update
The Fund owns working interests and has participated in the drilling of six wells, two that are currently drilling or scheduled to drill, one well that was determined to be a dry hole, and three wells that have been determined to be successful. During the third quarter 2008, the Fund elected to abandon one of its wells as detailed in the Main Pass 30 discussion below.
Recent hurricane activity in the Gulf of Mexico has not caused material damage to any of the Fund’s wells or facilities. However, damage to certain pipelines, coastal refineries and gas processing plants have caused them to be shut-down for several weeks or months. Accordingly, certain of the Fund’s producing properties generated little or no revenue during the month of September.
10
Future Projects
Neptune Project
In July 2008, the Fund acquired a 6.0% interest in the Neptune Project, an exploratory well, which is operated by Newfield Exploration Company (“Newfield”). This project is expected to begin drilling in November 2008 and results are expected in February 2009. Through September 30, 2008, the Fund has spent $0.3 million on this well, for which the total estimated budget is $4.0 million.
Successful Projects
Emerald Project
In March 2008, the Fund acquired a 12.5% working interest in the Emerald project, from LLOG Exploration Offshore, Inc. (“LLOG”), the operator. The Emerald project was determined to be a commercial success in May 2008 and has been completed. The Operator is currently constructing facilities and related infrastructure and production is expected during the first quarter 2009. Through September 30, 2008, the Fund has spent $6.6 million related to this property, for which the total estimated budget is $12.6 million, which includes the drilling of two additional wells.
Main Pass 30
The Fund acquired a 45.0% working interest from the operator, Chevron U.S.A., Inc. (“Chevron”). During the second quarter, the Fund and Chevron have revised the number of wells for this project from five to three. The total cost of the three wells in the Main Pass 30 field through September 30, 2008 is $42.1 million, inclusive of facilities upgrades.
Well #1/Well #2
The first well in the Main Pass 30 project, (“Main Pass 30 well #1) began production in June 2006 and is currently producing at a substantially reduced rate. In order to improve the flowrate of production, the Fund and Chevron believe a re-completion effort would be required however there are no plans to expend additional capital on this well.
The second well in the Main Pass 30 project (“Main Pass 30 well #2”) began drilling in May 2007 and was determined to be a commercial discovery during the second quarter of 2007. Production commenced on this property in July 2007. In February 2008, Main Pass 30 well #2 stopped flowing gas due to a mechanical problem. During the second and third quarters, Chevron completed a workover process, which removed and replaced the tubing in an effort to facilitate the flow of natural gas and oil. This workover effort has not proved successful and the Fund and Chevron have elected to plug and abandon this well.
As a result of this decision, the Fund determined that the Main Pass 30 field was impaired and recorded an impairment loss totaling $19.6 million. At September 30, 2008, the unamortized remaining balance of the Main Pass 30 field’s proved properties, which excludes Main Pass well #3, is $0.4 million.
Well #3
The third well in the Main Pass 30 project (“Main Pass 30 well #3”) began drilling in October 2007. The Fund expected drilling results for this project in December 2007, however, during drilling Chevron encountered a mechanical problem, or underground “blowout”, caused by a small pocket of gas. At September 30, 2008, an insurance claim has been filed by the Fund totaling $4.5 million, of which the Fund expects to recover $4.0 million, net of the $0.5 million insurance deductible. Drilling is currently expected to resume in November 2008 upon availability of a drilling rig. The Fund has obtained estimates indicating its total costs to complete the well, inclusive of a sidetrack, would be $9.4 million, net of estimated insurance recoveries. At September 30, 2008, the Fund has spent $7.5 million related to this well, excluding amounts expended related to the insured loss of control event.
11
Results of Operations
The following review of operations for the three and nine months ended September 30, 2008 and 2007 should be read in conjunction with the Fund’s financial statements and the notes thereto.
| | | | | | | | | | | | | |
| | Three months ended
September 30, | | Nine months ended
September 30, | |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | |
| | (in thousands) | |
| | | | | | | | | | | | | |
Revenue | | | | | | | | | | | | | |
Oil and gas revenue | | $ | 53 | | $ | 4,527 | | $ | 2,324 | | $ | 9,144 | |
| | | | | | | | | | | | | |
Expenses | | | | | | | | | | | | | |
Impairment of proved properties | | | 19,579 | | | — | | | 19,579 | | | — | |
Workover expenses | | | 2,670 | | | — | | | 4,372 | | | — | |
Depletion and amortization | | | 40 | | | 2,702 | | | 1,682 | | | 5,541 | |
Dry-hole costs | | | 31 | | | 1 | | | (94 | ) | | 86 | |
Management fees to affiliate | | | 653 | | | 653 | | | 1,958 | | | 1,961 | |
Operating expenses | | | 131 | | | 138 | | | 606 | | | 664 | |
General and administrative expenses | | | 130 | | | 120 | | | 567 | | | 630 | |
| | | | | | | | | | | | | |
Total expenses | | | 23,234 | | | 3,614 | | | 28,670 | | | 8,882 | |
| | | | | | | | | | | | | |
(Loss) income from operations | | | (23,181 | ) | | 913 | | | (26,346 | ) | | 262 | |
Other income | | | | | | | | | | | | | |
Interest income | | | 173 | | | 752 | | | 738 | | | 2,412 | |
| | | | | | | | | | | | | |
Net (loss) income | | | (23,008 | ) | | 1,665 | | | (25,608 | ) | | 2,674 | |
Other comprehensive income | | | | | | | | | | | | | |
Unrealized gain on marketable securities | | | 75 | | | — | | | 115 | | | — | |
| | | | | | | | | | | | | |
Total comprehensive (loss) income | | $ | (22,933 | ) | $ | 1,665 | | $ | (25,493 | ) | $ | 2,674 | |
| | | | | | | | | | | | | |
Oil and Gas Revenue. During the three and nine months ended September 30, 2008, the Fund had two producing wells, Main Pass 30 well #1 and well #2, which came onto production in June 2006 and July 2007, respectively. Oil and gas revenue for the three months ended September 30, 2008 was $53 thousand, a $4.5 million decrease from the three months ended September 30, 2007. The decrease is principally attributable to a decrease in production and sales volumes.
The Fund’s wells had no oil production or revenue during the three months ended September 30, 2008. During the three months ended September 30, 2007, oil production was approximately 15 thousand barrels. The Fund’s oil prices averaged $76 per barrel during the three months ended September 30, 2007.
The Fund’s wells’ gas production during the three months ended September 30, 2008 was approximately 6 thousand mcf compared to 516 thousand mcf, during the three months ended September 30, 2007. During the three months ended September 30, 2008, the Fund’s gas prices averaged $9.51 per mcf compared to $6.53 per mcf during the three months ended September 30, 2007.
Oil and gas revenue for the nine months ended September 30, 2008 was $2.3 million, a $6.8 million decrease from the nine months ended September 30, 2007. The decrease is attributable to a decrease in production and sales volumes totaling $7.3 million partially offset by the impact of increased average prices totaling $0.5 million.
The Fund’s wells produced approximately 2 thousand barrels of oil during the nine months ended September 30, 2008 compared to 18 thousand barrels during the nine months ended September 30, 2007. The Fund’s oil prices averaged $95 per barrel during the nine months ended September 30, 2008 compared to $73 per barrel during the nine months ended September 30, 2007.
The Fund’s wells’ gas production during the nine months ended September 30, 2008 was approximately 229 thousand mcf compared to 1.1 million mcf, during the nine months ended September 30, 2007. During the nine months ended September 30, 2008, the Fund’s gas prices averaged $9.29 per mcf compared to $7.16 per mcf during the nine months ended September 30, 2007.
12
The decrease in sales volumes for both the three and nine months ended September 30, 2008 was principally attributable to ongoing workover efforts on Main Pass 30 well #2. See also “Business Update – Main Pass 30” for further discussion.
Impairment of Proved Properties. During the three and nine months ended September 30, 2008, the Fund determined that the Main Pass 30 field was impaired and has recorded an impairment loss totaling $19.6 million. See also “Business Update – Main Pass 30” for further discussion. For the three and nine months ended September 30, 2007, no impairments were recorded.
The fair value used in the impairment calculation was based upon futures pricing at the date of the calculation. In determining the fair value, the Manager relies upon a number of factors including reserve data and futures pricing of oil and gas as of the date of calculation. There are inherent uncertainties related to these factors and judgments in applying them to the impairment analysis. Reservoir engineering is a subjective process of estimating underground accumulations of gas and oil that cannot be measured in an exact manner. The reserve estimates are based upon the quality of available data and engineering and geological interpretation and judgment. Revisions to estimated reserves may result from actual production, results of future development and exploration activities, prevailing oil and gas prices, operating costs and other factors. Changes to these factors and judgments may result in additional impairments.
Workover Expenses. Workover expenses for the three and nine months ended September 30, 2008 were $2.7 million and $4.4 million, respectively. These costs are related to Main Pass 30 well #2, which experienced a mechanical problem and required a workover to remove and replace tubing in an effort to facilitate the flow of gas and oil. See also “Business Update – Main Pass 30” for further discussion.
Depletion and Amortization. Depletion and amortization for the three months ended September 30, 2008 and 2007 were $40 thousand and $2.7 million, respectively. For the nine months ended September 30, 2008 and 2007, depletion and amortization was $1.7 million and $5.5 million, respectively. The decrease in depletion and amortization resulted from decreased production for the Main Pass 30 field as discussed inOil and Gas Revenueabove.
Dry-hole Costs. Dry-hole costs are those costs incurred to drill and develop a well that is ultimately found to be incapable of producing either oil or gas in sufficient quantities to justify completion of the well. The following table summaries dry-hole costs inclusive of plug and abandonment costs and credits. During the nine months ended September 30, 2008, the Main Pass 221 project received credits from the Operator based upon review and audit of the well costs.
| | | | | | | | | | | | | |
| | Three months ended
September 30, | | Nine months ended
September 30, | |
Lease Block | | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | | |
| | (in thousands) | |
Main Pass 221 | | $ | 31 | | $ | 1 | | $ | (94 | ) | $ | 86 | |
Management Fees to Affiliate. For each of the three and nine months ended September 30, 2008 and 2007, the Fund incurred management fees of $0.7 million and $2.0 million, respectively, representing 2.5% of total capital contributions, net of cumulative dry-hole and related well costs incurred by the Fund. The management fee, payable monthly to the Manager, is for expenses associated with overhead incurred by the Manager for its ongoing management, administrative and advisory services. Such overhead expenses include but are not limited to rent, payroll and benefits for employees of the Manager, and other administrative costs.
Operating Expenses. Operating expenses represent the costs of operating and maintaining wells and related facilities costs, geological costs and accretion expense, as detailed in the schedule below.
| | | | | | | | | | | | | |
| | Three months ended
September 30, | | Nine months ended
September 30, | |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | |
| | (in thousands) | |
Lease operating expenses | | $ | 128 | | $ | 136 | | $ | 455 | | $ | 547 | |
Geological costs | | | — | | | — | | | 143 | | | 113 | |
Accretion expense | | | 3 | | | 2 | | | 8 | | | 4 | |
| | | | | | | | | | | | | |
|
Total operating expenses | | $ | 131 | | $ | 138 | | $ | 606 | | $ | 664 | |
| | | | | | | | | | | | | |
Lease operating expenses for the three and nine months ended September 30, 2008 and 2007 were related to the onset of production of Main Pass well #1 and well #2. Geological costs for the three and nine months ended September 30, 2008 related to geological surveys for the Emerald project. Geological costs for the nine months ended September 30, 2007 related to the Main Pass 30 well #2 platform.
13
General and Administrative Expenses.General and administrative expenses represent costs specifically identifiable or allocable to the Fund, as detailed in the schedule below.
| | | | | | | | | | | | | |
| | Three months ended
September 30, | | Nine months ended
September 30, | |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | |
| | (in thousands) | |
Accounting fees | | $ | 87 | | $ | 40 | | $ | 212 | | $ | 164 | |
Insurance | | | 28 | | | 60 | | | 306 | | | 405 | |
Trust fees and other | | | 15 | | | 20 | | | 49 | | | 61 | |
| | | | | | | | | | | | | |
Total general and administrative expenses | | $ | 130 | | $ | 120 | | $ | 567 | | $ | 630 | |
| | | | | | | | | | | | | |
Accounting fees represent annual audit and tax preparation fees, quarterly reviews and filing fees of the Fund. Insurance expense represents premiums related to producing well and well control insurance, which varies dependent upon the number of wells producing and/or drilling and directors and officers’ liability policy, which is allocated by the Manager to the Fund based on capital raised by the Fund to total capital raised by all oil and gas funds managed by the Manager. Trust fees represent bank fees associated with the management of the Fund’s cash accounts.
Interest Income. Interest income is comprised of interest earned on money market accounts and investments in U.S. Treasury securities. For the three months ended September 30, 2008, interest income was $0.2 million, a $0.6 million decrease from the three months ended September 30, 2007. For the nine months ended September 30, 2008, interest income was $0.7 million, a $1.7 million decrease from the nine months ended September 30, 2007. The decreases were attributable to a reduction in interest rates during the three and nine months ended September 30, 2008 coupled with a decrease in average outstanding balances earning interest due to ongoing capital expenditures.
Unrealized Gain on Marketable Securities.During 2008, the Fund purchased long-term available-for-sale U.S. Treasury securities, which mature in February 2010. Unrealized gains related to the securities’ change in fair value are recorded in other comprehensive income until realized. The Fund recorded an unrealized gain of $75 thousand and $0.1 million during the three and nine months ended September 30, 2008, respectively. For the three and nine months ended September 30, 2007 there was no unrealized gain or loss on marketable securities.
Capital Resources and Liquidity
Operating Cash Flows
Cash flows used in operating activities for the nine months ended September 30, 2008 were $1.9 million, which were primarily related to management fees of $2.0 million, workover expenses paid of $3.2 million, operating expenses paid of $0.6 million and general and administrative expenses of $0.6 million. These amounts were partially offset by revenue received of $3.9 million and interest income received of $0.5 million.
Cash flows provided by operating activities for the nine months ended September 30, 2007 were $6.9 million, primarily related to revenue receipts of $8.7 million and interest income received of $1.6 million, partially offset by management fees of $2.0 million, operating expenses of $0.7 million, general and administrative expenses of $0.6 million, and unfavorable working capital of $0.1 million.
Investing Cash Flows
Cash flows provided by investing activities for the nine months ended September 30, 2008 were $9.0 million. Proceeds from the maturity of held-to-maturity investments were $57.1 million. These receipts were partially offset by capital expenditures for oil and gas properties, inclusive of advances, totaling $14.3 million, investments in held-to-maturity securities totaling $24.0 million and investments in available-for-sale securities totaling $9.8 million. Additionally, the Fund increased its salvage fund investments by $22 thousand, which consisted of the interest earned on this account.
Cash flows used in investing activities for the nine months ended September 30, 2007 were $30.4 million, primarily related to investments in held-to-maturity securities of $55.1 million and capital expenditures for oil and gas properties of $12.3 million, partially offset by proceeds from the maturity of held-to-maturity investments of $37.1 million. Additionally, the Fund increased its salvage fund investments by $37 thousand, which consisted of the interest earned on this account.
14
Financing Cash Flows
Cash flows used in financing activities for the nine months ended September 30, 2008 were $3.5 million related to distributions to the Manager and the shareholders.
Cash flows used in financing activities for the nine months ended September 30, 2007 were $8.3 million related to distributions to the Manager and the shareholders.
Estimated Capital Expenditures
The Fund has entered into multiple offshore operating agreements for the drilling and development of its investment properties. The estimated capital expenditures associated with these agreements can vary depending on the stage of development on a property-by-property basis. As of September 30, 2008, the Fund had commitments related to participation agreements totaling $19.0 million for properties.
When the Manager makes a decision for participation in a particular project, it assumes that the well will be successful and allocates enough capital to budget for the completion of that well and the additional development wells and infrastructure anticipated. If the exploratory well is deemed a dry-hole or if it is un-economical, the capital allocated to the completion of that well and to the development of additional wells is then reallocated to a new project or used to make additional investments.
Liquidity Needs
The Fund’s primary short-term liquidity needs are to fund its operations, including management fees and capital expenditures, with existing cash on-hand, short-term investments and income earned therefrom. The Manager is entitled to receive an annual management fee from the Fund regardless of whether the Fund is profitable in that year. The annual fee, payable monthly, is equal to 2.5% of total capital contributed by shareholders, net of cumulative dry-hole and related well costs incurred.
With respect to the payment of management fees, until one of the Fund’s projects begins producing, all or a portion of the management fee is paid generally from the interest or dividend income generated by the Fund’s development capital that has not been spent, although the management fee can be paid out of capital contributions. Such interest and/or dividend income is expected to be sufficient to cover Fund expenses, including the management fee. However in periods of declining interest rates, and as the Fund expends its capital on projects, interest and/or dividend income may not be sufficient, which would require the Fund to use capital contributions to fund such expenses. Generally, it can take anywhere from 18 to 24 months to bring a project to production. Once a well is on production, the management fee and fund expenses are paid from operating income. Although the management fee can be paid out of capital contributions, this is not the Fund’s intent.
Distributions are funded from cash flow from operations, and the frequency and amount are within the Manager’s discretion subject to available cash from operations, reserve requirements and Fund operations.
The capital raised by the Fund in its private placement is more than likely all the capital it will be able to obtain for investments in projects. The number of projects in which the Fund can invest will naturally be limited and each unsuccessful project the Fund experiences, if any, will not only reduce its ability to generate revenue, but also exhaust its limited supply of capital. Typically, the Manager seeks an investment portfolio that combines high and low risk exploratory projects.
Off-Balance Sheet Arrangements
The Fund had no off-balance sheet arrangements as of September 30, 2008 and December 31, 2007 and does not anticipate the use of such arrangements in the future.
Contractual Obligations
The Fund enters into operating agreements with operators. On behalf of the Fund, an operator enters into various contractual commitments pertaining to exploration, development and production activities. The Fund does not discuss or negotiate any such contracts. No contractual obligations exist at September 30, 2008 and December 31, 2007 other than those discussed in “Estimated Capital Expenditures” above.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, the Fund carried out an evaluation, under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Fund’s disclosure controls and procedures were effective as of September 30, 2008.
There has been no change in the Fund’s internal control over financial reporting that occurred during the three months ended September 30, 2008 that has materially affected, or is reasonably likely to materially affect, the Fund’s internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no changes to the legal proceedings disclosed in the Fund’s most recent Annual Report on Form 10-K.
ITEM 1A. RISK FACTORS
Not required.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
16
ITEM 6. EXHIBITS
| | | | |
EXHIBIT
NUMBER | | TITLE OF EXHIBIT | |
| | | | |
| | | |
| 10.1 | | Participation Agreement between LLOG Exploration Offshore, Inc. and Ridgewood Energy Corporation as Manager for Emerald Project. (previously filed) |
| 10.2 | | Participation Agreement between Newfield Exploration Company and Ridgewood Energy Corporation as Manager for Neptune Project. |
| 31.1 | | Certification of Robert E. Swanson, Chief Executive Officer, pursuant to Securities Exchange Act Rule 13a-14(a). |
| 31.2 | | Certification of Kathleen P. McSherry, Chief Financial Officer, pursuant to Securities Exchange Act Rule 13a-14(a). |
| 32 | | Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, signed by Robert E. Swanson, Chief Executive Officer of the Company and Kathleen P. McSherry, Chief Financial Officer of the Company. |
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | | | | | |
Dated: | October 30, 2008 | | | | | RIDGEWOOD ENERGY Q FUND, LLC | |
| | | | | | | |
| | By: | | /s/ | | ROBERT E. SWANSON | |
| | | | | | | | |
| | | | Name: | | Robert E. Swanson | |
| | | | Title: | | President and Chief Executive Officer |
| | | | | | (Principal Executive Officer) | |
| | | | | | | |
Dated: | October 30, 2008 | | | | | | |
| | By: | | /s/ | | KATHLEEN P. McSHERRY | |
| | | | | | | | |
| | | | Name: | | Kathleen P. McSherry | |
| | | | Title: | | Executive Vice President and Chief Financial Officer |
| | | | | | (Principal Financial and Accounting Officer) |
18
